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Death Incentives

Mean Professor Anderson made his first year law and economics class memorize Greg Mankiw’s ten basic principles of economics, including … incentives matter. Also, people make decisions at the margin. One of the interesting questions – more than interesting, genuinely crucial to how one understands and interacts with other people – is when those heuristics don’t apply, however. Spheres of social, interpersonal, intimate, familial, etc., life in which one eschews making decisions at the rationality margins, and instead goes with relational and affective values that are not “scalable” in the sense that marginal decision-making requires.

And then there is the vexed question of when one might think in terms of one, or the other, or both … which brings us to the question of the estate tax, as this Wall Street Journal article observes. Last year, people had an incentive to stay alive, and their heirs had an incentive to keep them alive, until January 1, 2010, in order to avoid the estate tax. It will go into reverse, however, at the end of the year:

When the Senate allowed the estate tax to lapse at the end of last year, it encouraged wealthy people near death’s door to stay alive until Jan. 1 so they could spare their heirs a 45% tax hit. Now the situation has reversed: If Congress doesn’t change the law soon—and many experts think it won’t—the estate tax will come roaring back in 2011. Not only will the top rate jump to 55%, but the exemption will shrink from $3.5 million per individual in 2009 to just $1 million in 2011, potentially affecting eight times as many taxpayers. The math is ugly: On a $5 million estate, the tax consequence of dying a minute after midnight on Jan. 1, 2011 rather than two minutes earlier could be more than $2 million; on a $15 million estate, the difference could be about $8 million.

It is a question of incentives for the wealthy person, of course – but also a question for their heirs. There is the question of perverse incentives but also, as the article discusses further, many questions of regulatory uncertainties clouding the very calculation of incentives. Will Congress act? At what rates and what exemptions? Crucially, will any of it be retroactive? Which leads to another basic principle … uncertainty raises costs.

Advisers say the estate-tax dilemma is especially awkward for heirs. “At least in December 2009, people wanted to keep their relatives alive,” says Ronald Aucutt, an estate-tax attorney with McGuire Woods in the Washington area. Now he and others are worried that heirs may be tempted to pull plugs on Dec. 31. Economists might call the taking of a life to reap a tax advantage a “perverse incentive.” District attorneys might call it homicide.

I suspect the plug-pulling problem or potential homicide problem by heirs exaggerated. So I’d like to think, anyway. Still, perverse incentives are perverse incentives.